Funding of High Tech Start-Ups

Telecom Forum 2003

Helsinki University of Technology, 14 October 2003

Vesa Sadeharju

Director, 3i Finland

2

Vesa Sadeharju - My background

• MSc. (Eng.) and MSc. (Econ.)

• responsible for technology investments in 3i Finland

• seven years experience on venture capital business. Co-founder and Director in IT and Telecommunications with SFK Finance Oy

• joined 3i in 2000 when 3i acquired SFK Finance Oy

• has been involved in the industrial electronics and automation industry since 1982 in division management, profit centre managment, product development and marketing with ABB

• has been a board member of 14 technology companies, currently e.g. in Meridea Financial Software Oy and Mitron Oy.

3

3i

• Founded in 1945

• FTSE 100 and Eurotop 300 member

• Invested over £15 billion in more than 14.000 businesses

• 3i’s portolio, as at 31st March 2003, consisted of investments in over 2,000 businesses, with a combined valuation of £5 billion including co-investment funds

• Approx. 900 employees across the world

the Leading Venture Capital Company

4

3i Technology Facts

• In the 12 months to 31st March 2003, 3i invested 249 MEUR(including co-investment funds) in the 183 technology businesses. This represents almost 19% of total investment in the period.

• In the 12 months to 31 March 2003 3i invested on average approximately 1 MEUR in technology based businesses each working day (including co-investment funds).

• 3i has investments in 500 early stage technology companies which at the year-end were valued at almost 847 MEUR, representing approximately 15% of the total 3i portfolio value.

5

Funding of High Tech Start-Ups

• Why funding

• Funding sources

• VC business in the US and in Europe

• What should a high tech start-up company expect from a VC

• What does a VC expect from a high tech start-up company, investment criterias

• Funding process

• Value growth

• Cases

• Final thoughts

6

Overall portfolio increasedto €3.8bn in 783 companies

How to start?

7

Time / yearsCas

hflo

wWhy Funding?

+

_

1 2 3 4 5 6

8

Funding Sources

• Own or family pocket

• Business angels

• Government institutions− SITRA− National Technology Agency of

Finland− Finnvera− Finnish Industry Investments Oy

• Venture funding− private independent firms− subsidiaries of banks− corporate venturing

• Banks

• IPO, Initial Public Offering

9

Terms

• Business angel

• Venture capital

• Private equity

• Ordinary shares

• Preference shares

• Pre-money value

• Post-money value

• Exit

10

Christopher Columbus was the first to explore uncharted seas to the West –backed by venture capital – and options.

A crew of 87 experienced seamen accompanied Christopher on the Nina, Pinta, and Santa Maria

VC Business in the US and Europe

11

NASDAQ Performance From 1996-2002US Venture Capital Activity 1995-2003

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

1/2/96 6/6/96 11/8/96 4/17/97 9/22/97 2/27/98 8/4/98 1/8/99 6/16/9911/18/994/26/00 9/29/00 3/8/01 8/13/01 1/24/02

Dai

lyC

losi

ngSt

ock

Pric

e

Dai

lyTr

adin

gVo

lum

e(0

00's

)

99.6

52.4

36.5

21.219.214.49.65.1

10-16

0102030405060708090

100

1995 1996 1997 1998 1999 2000 2001 2002 2003Est.

Bill

ions

of $

inve

sted

12

The US Venture Industry

$300150500200X est.

$2832538922002

$82323861990

$343871980

$351281970

AverageCapital

Per Firm

Capital Under Management

$’s Billion#VC Firms

13

High-Tech Early-Stage7,9%

Non High-Tech Early-Stage2,1%

High-TechExpansion/Development

7,5%

Non High-Tech Expansion/Development

13,4%

Buyout

66,3%

Not Available2,7%

Source: EVCA

Expected Allocation of Funds Raised in 2002

€ 2.2 Billion available for Hitec Start-Ups in Europe

14

177

391

19 17 27 28 38

84

136

192

285

397 340

462

226

122 137115

205

418

265

325

449

0

50

100

150

200

250

300

350

400

450

500

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

M€

Nbr

Investments 1991 – June 2003in Finland

M€ / Nbr

Source: FVCA

15

Finnish VC Companies

3i Finland OyAboa Venture Management OyACR Capital OyAhlström Capital OyAmanda Capital OyjAura Capital OyBaltcap Management OyBio Fund Management OyCapMan Capital Management OyCIM Creative Industries Management OyConventum Capital OyDanske Venture PartnersEmerging Power Partners OyEQT Partners OyEqvitec Partners OyEuroventures Advisors OyFenno Management OyHead Industrial Partner OyHelmet Business Mentors OyHoltron Ventures OyInnofinance OyInnovationsKapitalMB Rahastot OyMenire OyjMidinvest Management OyNeomarkka Oyj

NEST Management OyNexit Ventures OyNordea Capital OyNordia Management OyNordic Mezzanine Oy AbOKO Venture Capital OyPanostaja OyjPrivanet Capital OyjProventure OySentio Invest OySiemens Mobile Acceleration FinlandSnV Partners OySolaris Asset Management OySponsor Capital OyStartupfactory OyStratos Ventures Ltd OySuomen itsenäisyyden juhlarahasto SitraSuomen Teollisuussijoitus OyTeknia Invest OyTeknoventure Management OyVeraventure OyVirtaa Hämeeseen KyVNT Management OyWedeco Management Oy Ab

16

Venture Capital in 2001

0 1 2 3 4 5 6 7

Finland

Europe

US

Average per round

€Millions

x 5.4

17

What does make VC´s cautious?

Lack of good exit routes

18

4Q 00 1Q 01

The IPO window has closed

IPO Activity in 2000-2001

Withdrawals

FilingsPricings

0

125

1Q 00 2Q 00 3Q 00

250

Information provided by Broadview

19

23012067

1836

1421

1042

# of Deals

Average Deal Size

Technology - related M&A

1Q 00 2Q 00 3Q 00 4Q 00 1Q 01

($MM)

0

50

100

200

250

150

Information provided by Broadview

20

Structure of a VC company

Management OyPartners

Fund I Ky Fund II Ky Fund III Ky

Investments, management, exits

Limited partneships- 10 year funds

InvestorsInsuarance companies, pension funds, corporates, government

Commitments 2…4%

Investments in cash

Final returns after closing the funds

How does a VC company operate?

21

The Investment Process

Preliminaryanalysis

Agreement ofkey terms

Due diligence- commercial- financial- legal

Transaction agreements,Financing

ClosingClosing

Letter of Intent

Signing of binding

agreement

2-4 weeks2-4 weeks 6-8 weeks6-8 weeks

- In case everything is fine: 2-3 months- But in practice 6-16 month cycle including networking, iteration and sharpening of business plan

22

Practical process by entrepreneur

• Set your priorities and criterias

• Make a list of potential investors− focus, expertise, networking, hands-on or hands-off, capacity for further

rounds, persons

• As integrated activities− write a business plan and outline financial projections− contact potential investors

• Presentations, negotiations

• Sign the Term Sheet

• As integrated activities− Due Diligence− Negotiate Share Holders´ Agreement

• Signing

Entrepreneur’s view

Source: Mårten Mickos, MySQL

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Why to have a VC?A simplified model• Company (originally)

− turnover € 1m− founders own 100%

• Investment− valuation according P/S

(price per sales) om 1,5− pre-money € 1,5m− investment of € 1m− post-money € 2,5m− founders´ stake 60%,

venture capitalist 40%

• Exit− turnover € 5m− P/S now 3− valuation € 15m− founders´ stake € 9m− venture capitalist share € 6m

• What this would have been without vc?− turnover maybe € 3m− P/S about 2− valuation € 6m – founders

get all− conclusion: founders earn €

3m for sharing their power

Entrepreneur’s view

Source: Mårten Mickos, MySQL

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Basically the VC looks for high market potentials with high probability of success

Lähde: Advent International

High

Low

Mar

ket s

ize

Low High

Probability of success

What does a VC Company Look For?

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Technology Investors Look For

Entrepreneurs and his team

Technology Market

Businessconcept

- a growing market with big need- disruptive, sustainable compelling advantage

- change market or create a new one

- global in nature

- commitment to management excellence

-how to make money- visio- strategy- execution- timing

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Source: Atlas Ventures

0102030405060708090

100

1 2 3 4 5 6

Capital Value Risk

Phases: - 1-3 Forming- 4-5 Technology Leader- 6- Market Leader

Risks:- first increases and then decreases rapidly

Value explodes:- 1. Technology Leader- 2. Market Leader

Index

Development Phases of New Business

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Capital

Funding to Milestones

Risk (ß)

Valuation

Idea isFeasible

TechnologyWorks

A CustomerBuys

SeedFunding

R&DCapital

Go-to-MarketCapital

ExpansionCapital

P(success) = 30%Req’d IRR = 100%

P(success) = 40%Req’d IRR = 70%

P(success) = 50%Req’d IRR = 50%

P(success) = 80%Req’d IRR = 30%

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A Generic Model

Round Type Date

Amount Raised (MM)

Pre-Money Valuation

(MM) IRR Multiple

1 Seed Jan-00 € 0.50 € 2 101% 32.53

2 1st Jan-01 € 3.00 € 10 70% 8.13

3 2nd Jan-02 € 8.00 € 32 50% 3.30

4 3rd Jan-04 € 13.50 € 100 32% 1.32

5 IPO Jan-05 € 150

Total Private Capital € 25 Million

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Where Are the Opportunities?

• In 90´s − cut the wire− extremely clear value value to us

• What next?

Expand to low ARPU markets

- avoid building fixed lines, great advantage

- get real high volumes

Develop new reasons to buy a handset

- multimedia etc.New technologies > 10 years

- new architecture

- limitless brodband scalability

- really open interfaces

-

Do telecom players grow?

30

Succes Profile of Early Stage Tech Fund

• out of 10 start-up investments− 4 failures− 3 money back− 3 good return

• 1 out of 20 is a bright starthe world is open for succesfull serial entrepreneurfailure is not the end of game, cumulative experience is the corestone

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Success profile of a tech fund

-20 0 0 0 0 00

0

20 0 0 0 0 00

40 0 0 0 0 00

60 0 0 0 0 00

80 0 0 0 0 00

100 0 0 0 0 00

120 0 0 0 0 00

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3i Wireless Investments

Components

Infrastructure

Hardware WirelessCarriers

Devices Services & Content

CSR, UK (Bluetooth.WLAN chips)

Sychip, US (RF Modules)

Elixent, UK (Reconfigureable chips)

SiGe, US (Silicon germanium integrated circuits)

Celestix, SG (Secure CPEs)

Swe-dish, SE (Satellite equipment)

Avitec, SE (Repeaters)

Fractus, SP (Antennae)

PhotonEx, US (Long haul fast opto routers)

White Rock, US (Opto multi-service MUXs)

3G Lab, UK (Customisable UI’s)

Magic4, UK (Messaging solutions)

Bitfone, US (OTA re-Flash)

Eleksen, UK (Flexible keyboards)

Hotsip, SW (Presence based multi-media comms

Sonim, US (Push to Talk)

Fathammer, FI (Games platform)Macalla, IR (Wireless top-up)

Buongiorno, IT(Mobile marketing) SkyStream Networks (Rich Media Routers)

Mobile Commerce, UK (MBS Services)Kiwee, FR (Mobile Marketing)

Mobileway, UK (Mobile transactions)

Infrastructure

Software

Xenicom, UK (Infrastructure management)

CPS, UK (Location)

Kineto, US (Bluetooth/WiFi to cellular roaming)

Wificom, FI (WLAN Provisioning)

Quarry, US (Network defense)

Streamcore, FR, (Bandwidth optimisation)

Consumer

Enterprise

CRF Box, FI (Pharmaceutical testing)

Viair, US (Wireless email)

Intuwave, UK (Customer Care)

O3sis, DE (Wireless Knowledge mgt)

Telisma, FR (Speech solutions)Meridea, FI (Wireless banking)

Seasam House, FI

Cometa Networks, USA (WiFi Carrier)

33

VC Backed Companies in the US

• Apple

• Digital Equipment

• Compaq

• Intel

• Sun Microsystems

• Microsoft

• Genentech

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Final thoughts

• Fundmental of funding: ” I will be an entrepreneur”

• You and your team will be funded

• Cash from sales is best money

• Second best money is equity

• High risk high return, what other choices do we have?

• Valuation of technology companies is a blend of art and science, beware of analysts bearing bizarre metrics

• Traditional business fundamentals are still key

• It is not a technology play